I’m OK, Your 401(k)?

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With a two-year decline in stock prices — particularly the mass sell-off of the past two weeks — it appears that some workers are starting to have serious doubts about their retirement investments.

To wit: on July 23 transaction activity in 401(k) accounts was about three times normal levels. According to Hewitt Associates, employees were busy dumping their equity funds and moving into fixed-income accounts.

As a result of all that dumping, that day marked the sixth-busiest day for 401(k) plan activity since Hewitt began tracking such transactions in August 1997, according to Dow Jones.

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The highest level of 401(k) rejiggering this year came at the end of March. The busiest day ever for 401(k) transactions was September 17 — the first day the equity markets were open following the terrorist attacks of 9/11.

Then again, even unusually high 401(k) activity doesn’t move the market needle all that much. Monday’s 401(k) transaction volume, for example, still only represented movement of 0.22 percent, or $165 million, of the $75 billion in 401(k) assets tracked by Hewitt.

In fact, in a recent study of employee investment patterns, Hewitt reported that workers fiddled less with their 401(k) plans in 2001 — even though the major stock markets were in full retreat last year.

Consultants at Hewitt believe this relative lack of 401(k) activity means employees are not using the benefit as well as they could. (Hewitt sells 401(k) services to employers.)

Last year “was one of the more difficult years for 401(k) plans ever, due to stock market volatility and the controversy over company stock use,” said Lori Lucas, a defined contribution consultant at Hewitt Associates. “It was less rewarding and more challenging for employees to manage their investments last year, and consequently, many people decided to disengage from any 401(k) activity.”

In 2001, only 20 percent of active 401(k) participants conducted any form of investment transaction. This was down substantially from 2000, when 30 percent of participants made at least one trade.

Of course, the drop in 401(k) activity may mean employees simply decided to stick with their investments rather than sell at a loss. In the bull market days of 2000, workers were often able to cash out investments at a profit. And many changed their asset allocations, transferring 401(k) money into hot sectors such as technology and Internet stocks.

But apparently Lucas doesn’t see that. “While it is gratifying to see that in the face of events such as September 11, 401(k) participants did not panic, the fact that less than one in five participants proactively interacted with their 401(k) plan is telling,” she noted. “People basically disconnected from the investment process.”

The asset allocation trends are even more interesting. In 2001, the proportion of 401(k) assets in equities shrunk to 76 percent from 81 percent. Some observers say investors simply started to get out of equities in the face of the crumbling stock markets.

But in fact, this slight shrinkage was mostly due to market movements. “This is not active market timing,” stated Lucas. “But the potential long-term impact on wealth building is the same. Participants who allow their asset allocation to be dictated by market movements clearly haven’t heard employers’ messages about matching asset allocation targets to long-term goals and risk tolerance.”

In its survey, Hewitt examined the savings and investment behavior of nearly 800,000 eligible U.S. employees and more than 500,000 active 401(k) participants in 2001.

Other findings:

The number of funds held by an average 401(k) plan participant increased to 3.6 in 2001 from 3.3 in 2000, on average. That’s hardly a well-diversified portfolio, however, particularly since…

…the bulk (75 percent) of 401(k) participants’ assets remain in only a few asset classes — company stock, large U.S. equity funds, and GIC/stable value funds. Few participants invest in global funds (non-U.S. securities) or international funds (non-U.S. and U.S. securities). (Some observers believe that investment covariance may make a comeback, however — if U.S. markets continue to fall or remain flat for a long period of time.)

Nearly 30 percent of participants have at least three-quarters of their plan balances in company stock, despite the widespread publicity over the implosion of Enron employees’ retirement accounts.

Approximately 15 percent of participants have all of their balances in company stock. More worrisome: one-third of participants age 60 or older had at least 75 percent of their total plan balance in company stock. Nearly 20 percent had all of their balance in company stock.

That, of course, raises the question: don’t employers have an obligation, under the Employee Retirement Income Security Act, to make sure plan participants have a rudimentary understanding of investment theory? Or are they more interested in aligning the interests of workers with those of shareholders?

“These results point to why employers are focusing so much energy on educating employees about diversification generally,” said Lucas, “and specifically, on the risks associated with concentrating investments in an individual security.”

If employers are truly focusing on educating employees about 401(k) plan diversification, the survey indicates they’re doing a damned poor job of it.

“Guidance and advice are tools that employers are increasingly investigating as a potential means of helping employees understand the impact of poor diversification,” added Lucas. “Targeted communication, including pushing specific messages out to employees via E-mails or statements, is another tool we’re hearing a lot about with respect to this issue.”

As a rule, Lucas noted, 401(k) investors are not an active group. “Instead of driving employees to really take charge of their 401(k) plans, recent events have had the opposite result,” she stated. “It’s imperative that employees actively engage in the investment process in order to maximize their 401(k) benefit.”